The Gilmo Report

August 17, 2011

August 17, 2011

The general market indexes have all formed what I refer to as “black crosses” with their 50-day moving averages now dipping below their 200-day moving averages. You will hear these referred to as “death crosses,” but way back in the early 1990’s when I first started in the business as a rookie broker I heard an old-timer refer to it as a “black cross” and so I’ve called it that ever since. Whatever you want to call it, it merely serves to add some confirmation as to how weak the market has been as we glance in the rear-view mirror. The critical factor going forward is where this initial weakness is likely to take us. Based on the action of former leading stocks my guess is that we will eventually clear to lower lows in the coming days and or weeks, but there could be some backing and filling here for a couple of days before that occurs, and it is still possible that we could see the NASDAQ Index make it to major resistance at 2600. In addition, today’s selling was not that heavy, so one could also interpret the action as consolidating the move off the lows of seven days ago. Even so, a pickup in volume as the indexes roll over at any point here would likely seal the deal.

NASDAQ Index Gilmo Report Chart

The NASDAQ ran into a headwind that was likely and largely due to the big-cap NASDAQ 100 Index (NDX) running into logical resistance of its own, as we see on the daily chart of the NDX, below. If the big stocks set the pace here, then the NDX is a useful index to keep an eye on as it ran right into resistance at around the 2200 level.

NASDAQ 100 Index (NDX) Gilmo Report Chart

As money continues to move into safe-haven Treasuries and the dollar flirts with support at the 73.45 level, gold has also continued to remain well above its 10-day moving average, as we see in the daily chart of the SPDR Gold Shares (GLD), below. Gold, however, is fairly extended here and deserving of a rest, so I am watching out for a little short-term double-top here to signal a pullback and consolidation for the yellow metal. This latest move back up towards last week’s highs is occurring on light volume, which may be suspect. On any pullback, one could decide to use the 10-day or 20-day moving averages as a selling guide.

SPDR Gold Shares (GLD) Gilmo Report Chart

I wrote over the weekend that a lot of broken-down former leaders were drifting back up to logical areas of resistance, such as their 50-day or 200-day moving averages, and Rackspace Holdings, Inc. (RAX) was a typical example. RAX broke down severely in early August and then staged a rally over the next week that took it just above its 200-day moving average and up into a prior low at 37.72. Once there, it finally found resistance and turned tail, as we see on the daily chart below. RAX is a classic example of how these “floater” rallies that occur on weak volume can drift just past a moving average before they find resistance at some other “logical” area. This is illustrative of why one must be persistent in trying to short a short-sale target stock as it rallies up to and around a key moving average. The trick is to simply understand this and allow yourself some flexibility as you initiate a position into such a rally. If I short a stock right around a moving average, I will mentally allow for some “seepage” as it may float a little further. I find that 3-5% stop-losses are usually effective, but if one is willing to be very active, shorting and covering and shorting again as one “works” a short position into a rally, then even tighter stops can be implemented. There is no science to this, it is simply a matter of deciding how much pain you are willing to sit through in order to give the short position a chance to work, and that is mostly a matter of personal risk preference. In RAX’s example you can see how it went about 3% past the 200-day line before rolling over again. First downside target from here: the prior low at 31.09.

Rackspace Holdings, Inc. (RAX)  Gilmo Report Chart

Another short-sale target that I discussed over the weekend as being shortable on this “floater” rally and which has also rolled over like a very obedient and well-trained puppy is Under Armour, Inc. (UA). As we see on the daily chart, below, as I discussed over the weekend, the stock was making a move for its 200-day moving average on volume that was decidedly wedging. Monday saw the stock skid just past its 200-day moving average, a very common maneuver for most short-sale targets engaging in such “floater” rallies, before picking up volume and breaking below its 200-day moving average. Today’s action saw some heavy, above-average volume come into the stock as it broke hard on the day. If you are short this one somewhere around the 200-day moving average, then you are looking at the 200-day line as your upside stop and a potential undercut of the prior low at 54.37 as your downside target. This one was almost too easy.

Under Armour, Inc. (UA) Gilmo Report Chart

Over the weekend I also briefly mentioned some other floaters like fertilizers Potash, Inc. (POT) and Mosaic (MOS), and both of those have rallied right up into resistance at or just past their 50-day moving averages. Although I don’t show them here on shorts, I believe they are shortable here using the 50-day moving averages plus 3-5% on each as a rough guide for an upside stop. Monsanto Company (MON), shown below on a daily chart, looks very similar to the fertilizer stocks as it recently broke down from a late-stage base that was extremely wide and loose, as we see on its daily chart below. The stock has wedged up into its 50-day moving average and today continued to float up into the line as volume remained weak. I think if you’re looking at this as a short-sale target you have no choice but to take an initial short position here looking to cover at or above the 50-day moving average plus 3-5%. If indeed it fails from here your initial downside target is the 63.03 prior low of last week. Most of the big agricultural stocks are in similar positions within their charts (POT, MOS, AGU, MON), with the exception of CF Industries (CF) which continues to make new highs. So we might look for a failed breakout by CF to coincide with the other “ag” stocks breaking down from their 50-day moving averages

Monsanto Company (MON) Gilmo Report Chart

All of the Chinese internets have been weak as of late, and all of them are in what could be late-stage base failures. The biggest of them all, Baidu, Inc. (BIDU), is the one I’ve focused on although I do believe Sina (SINA) and Sohu.com (SOHU), not shown on charts, should be shorted on any rallies into the 50-day at 101.37 on SINA and the 200-day moving average at 79.34 on SOHU. Like BIDU, which I show on a daily chart below, both have rolled over and broken down through key moving averages, with BIDU itself falling below its 50-day moving average for the second time in two weeks as volume picks up sharply. Note how BIDU was able to rally up into its 20-day moving average up around 150, something I discussed in my report of exactly one week ago today. This was a logical short-sale point, and I would look for the next short-sale point to occur on a continued rally up into the 50-day moving average at 104.35 or the top of the “falling Window” from the gap-down day of three days ago at around 142.70. In general, try to stick to 3-5% upside stops whatever your entry point. I don’t consider it likely that the stock will rally all the way back up to the 20-day moving average and so 143 is about as much as I’d give it on the upside.

Baidu, Inc. (BIDU) Gilmo Report Chart

Over the weekend I lamanted the fact that I was not seeing a lot of head and shoulders topping formations despite the fact that late-stage failed-bases (LSFBs) are all over the place. Carbo Ceramics, Inc. (CRR), however, is one LSFB that may be morphing into a head and shoulders type of set-up. As is typical of LSFBs, CRR failed on its push to new highs in the 80 area and plummeted below its 50-day moving average in a straight line, setting up a rally off the 200-day moving average which has pushed up into possible overhead supply congestion (highlighted area) in the basing formation from which CRR broke out of in early July, making it look like a possible right shoulder within an overall H&S formation. While this could continue rallying up into the 50-day moving average at 154.78, that is only about 5% from here, but it is possible that overhead congestion will take precedence here. Thus CRR is potentially shortable here using the high of today at 149.98 as a guide for a stop. Incidentally, although I don’t show a 65-day exponential moving average on this chart, today’s rally ran into resistance right at the 65-day e.m.a.

Carbo Ceramics, Inc. (CRR) Gilmo Report Chart

We’ve previously discussed Las Vegas Sands (LVS) as a late-stage failed-base set-up, and while I don’t show a chart of the stock here, in my view it is actually quite shortable at today’s 44.29 closing price just below the 200-day moving average at 44.67. Another big leader and cousin stock to LVS is Wynns Resorts (WYNN), shown below on a daily chart. WYNN is a late-stage failed-base set-up which broke very hard off of its peak after reversing on earnings in the latter part of July. When the market bounced seven days ago WYNN also bounced right off of its 200-day moving average and is now perched right on top of its 50-day moving average and right below its 20-day moving average. It is not uncommon for LSFB set-ups to rally back above the 50-day moving average and up into the 20-day line as we’ve seen with BIDU and PCLN, for example. WYNN found resistance at its 20-day moving average today on above-average volume, so a short position could be tested here using today’s high at 150.36 as your guide for an upside stop.

Wynns Resorts (WYNN) Gilmo Report Chart

Some notes from my Trading Diary on the other “big stock” short-sale targets I’ve discussed in the past couple of reports are below:

AMZN – still trading below its 50-day moving average after a potential LSFB. Remains potentially shortable with a 5% stop up to the 50-day moving average at 204.19, or, if one prefers, a little higher at the 20-day line now running through the 208.18 price level.

ISRG – rallied up near its 50-day moving average at 363.59 but did not quite get there, instead stopping just short of its 65-day exponential moving average at 359.76 before reversing today. ISRG looks similar to WYNN and CRR, and these set-ups are potentially quite playable using the proper stops on the upside.

PCLN – still trading below 50-day moving average after potential LSFB. Still potentially shortable on any rally up into the 50-day line up to the 20-day line at 510. If already short from those levels, the 200-day moving average at 471.62 is your initial downside target.

NFLX – has not presented a shortable move yet. Very close to its 200-day moving average so a bounce off that level should be watched.

Given that the market’s bounce off the lows of seven days ago is running into a little trouble here, I am more than willing to test out some short positions into the rally. Stocks like RAX and UA have met with immediate success, so it is this type of set-up we are looking for to capitalize on. There is still the possibility that the NASDAQ Composite “floats” higher towards logical resistance at the 2600 level, but the NASDAQ 100, representing the “big stock” NASDAQ drivers, has already run into its own resistance at the 2200 level on the NDX. The situation remains fluid, and I am trying to focus on what I think are the best short-sale set-ups here in a market where many stocks look potentially shortable, oddly enough. If the market continues higher and we are stopped out on some of these, so be it, but this is the spot to take your shots, in my view. After-hours I note that SINA is rallying up towards the high 90’s as I type, so this would likely be a prime area to potentially short the stock if it opens up near 100 tomorrow morning.

Gil Morales

CEO & Principal, Gil Morales & Company, LLC

Principal and Managing Director, MoKa Investors, LLC

At the time of this writing, of the stocks mentioned in this report, Gil Morales, MoKa Investors, LLC, and/or Gil Morales & Company, LLC held positions in MON and RAX , though positions are subject to change at any time and without notice.

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